Earn Potential Income of 17% a Year From This Well-Known Stock

Value investors always seem to emphasize the importance of buying stocks at the right price. Many of the largest and most successful value investors prefer to hold cash if they can’t find bargain-priced stocks. It is also possible to use cash waiting to be invested to earn significant amounts of income with an options trading strategy.

Options offer traders the right to buy or sell 100 shares of a stock at a specified price before a future date that is also specified in the options contract. Call options give buyers the right to buy the stock and put options give buyers the right to sell.

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Sellers of call options are obligated to sell the stock if the buyer exercises the option and put sellers will have to buy if the put buyer exercises. Options exercise is not usually an arbitrary decision. Call buyers exercise their positions when prices rise and put buyers exercise options when stock prices fall. There are a number of strategies traders can develop with these instruments, and selling puts on overvalued stocks is one that offers large potential gains.

Selling puts creates immediate income because the buyer pays a premium that the seller keeps no matter what. If the price of the stock the put is on remains above the exercise price, then the seller keeps the premium as the profit. If the price falls below the exercise price, then the seller will be obligated to buy the stock. Because it is possible you will own the stock after selling a put option, you should only sell puts on stocks that you wouldn’t mind owning at a price you’d be happy buy at.

Nike (NYSE: NKE) is an example of a company that would be nice to own; however, it is not a value stock. The company has delivered average earnings growth of about 7% a year during the past five years and is projected to see growth average 8% a year over the next five years. Despite the slow growth rate, NKE trades at an above average price-to-earnings (P/E) ratio of about 21.

Rather than paying the market price for NKE, traders can sell put options that would be exercised at $85 a share. At this price, NKE would be trading at about the same P/E ratio as the S&P 500 index based on next year’s estimated earnings.

December $85 put options are trading at about $0.26 and will expire in less than a month. Selling these options would generate about $26 in income per contract and would require a trader to post a margin of about $1,900 (20% of the cost of buying the stock). Although $26 seems like a small amount of money, it represents 1.4% of the required margin amount, a significant return for a one-month holding period.

If NKE falls about 12% in the next month and trades below $85, put sellers would have to buy the stock at a cost of about $84.74 ($85 strike minus $0.26 premium). If NKE does not fall that much, the $26 is income and traders could then sell an option expiring in January hopefully for a similar amount of income. Obtaining 1.4% a month offers an annualized return of about 17% a year.

NKE seems like the perfect stock for income investors interested in selling puts. The puts generate income and owning NKE, a long-term stock market winner that is likely to enjoy continued success in the future, is the worst-case scenario in this trade.

Recommended Trade Setup:

— Sell NKE Dec 85 Puts for $0.17 or more
— Do not use a stop-loss
— If NKE closes above $85 at expiration, this trade returns at least 1% in income